As China slowly exposes the country’s young stock and bond markets to foreign participation, its capital market has been put under the magnifying glass, as global investors on the hunt for opportunities assess the world’s second-largest economy.

CG Lai, CEO of BNP Paribas (China) Ltd., sat down with Caixin in an exclusive interview last week and offered his two cents on the country’s capital market reform, and how the authorities could boost the confidence of both domestic entrepreneurs and foreign investors.

Lai became the French lender’s China CEO on Monday, taking the helm of bank’s strategic planning and business development in China.

Foreign interest

One obvious change in the China capital market in recent years is the growing presence of foreign players, reflecting a slew of opening-up policies in the finance sector and the increasing purchases of Chinese bonds and equities by global managers.

Foreign investors have been flocking into Chinese bonds over the past few years, chasing their high yields and taking advantage of the Bond Connect, which since 2017 has allowed foreign investors to tap into onshore bonds from Hong Kong. The inflows are likely to continue in 2019, as Chinese bonds are set to be included into several international benchmark bond indexes including one provided by Bloomberg and Barclays.

Lai said there is “no doubt” that Chinese bonds will be included in global benchmark indexes, thanks to few macroeconomic elements. Firstly, China’s inclusion in the International Monetary Fund’s basket of official reserve currencies in October 2016 with a 10.6% weighting, which pushed central banks toward buying more Chinese government bonds. Secondly, the inclusion of onshore equities and bonds into global benchmark indexes has given fund managers greater scope to add yuan-denominated assets to their positions. Last but not least, the People’s Bank of China’s command over the yuan means global investors can have a relatively stable outlook about the currency and China’s economic growth.

Under such efforts, Chinese bonds have turned from a novelty item into a valuable asset, according to Lai. Foreign holdings of Chinese bonds surpassed 1.75 trillion yuan ($261 billion) as of the end of January, with a net monthly inflow of 25 billion yuan, according to data from the Shanghai Clearing House, one of China’s central securities depositories.

However the growing overseas interest is also testing the efficiency and governance of the market. The limited tools available for investors in the onshore market, and other risk factors such as accounting fraud and misconduct in bond ratings is hurting the credibility of the market, Lai said.

Think small

“China has successfully attracted foreign funds into its bond market, now it’s time to calibrate market efficiency, liquidity and hedging instruments to firm its foundation. This is to attract foreign investment in the long run, and to mitigate the market risks of unhedged underlying exposures,” Lai said. “The real money needs to be able to manage volatility to stay longer in the market.”

Lai said micro adjustments, instead of grand initiatives, should also be high on the agenda in China’s next round of market reforms. “We need to think about the missing roles in the market and helping it become more self-sustaining under the current circumstances,” Lai said. “Such adjustments are relatively complicated, even more complicated than market opening-up.”

Lai also called for expanded roles and responsibilities for various market participants, including accounting firms, rating agencies, independent directors and lawyers, to ensure investors can properly evaluate credit risks.

“There are cracks in each market, but we have to be sure of a few things: that accounting firms will guarantee accurate and effective financial statements to protect our interests; that independent directors will oversee the interests of other shareholders; that rating agencies can have access to all factual information to create its rating, and in case a company goes bankrupt, that legal procedures will be followed.”

Lai said there should be a greater use of credit instruments to optimize the market. Such instruments include credit default swaps (CDSs), and credit-linked notes, a security with an embedded CDS that allows the issuer to transfer a specific credit risk to investors.

“The biggest priority now is to optimize the market, not to create a bigger market,” Lai said. “There has been enough groundbreaking work done, and now the market needs to be ploughed and refined.”

The bank is involved in retail banking through a partnership with the Bank of Nanjing, a key player in China’s interbank bond market, in which it holds a 18% stake. It is also involved in China’s asset management business through its 49% stake in HFT Investment Management Co. Ltd., a joint venture with major onshore brokerage Haitong Securities.